Aggregate Demand

AD=CIGXn

AD =CIGXn Consumption• Main determinant is income

• Other determinants: – Wealth (value of assets) if W C S – Expectations (for TT% or future wealth)– Debts (if D increases, C & S will decrease)– Taxes (if T increase, C & S decrease, etc)

AD =CIGXn InvestmentInvestment is:–Business spending for capital stock–Most volatile component of AD/GDP–Assumed to require a loan–Decisions are based on

MC (i%) vs. MB(exp Rate of Ret)

AD =CIGXn Government Spending

• More Government Spending (AD)• Less Government Spending (AD)

AD =CIGXn Net Exports

• Xn are sensitive to: TrIPS– Taste/real interest rates/Investment/Price level/Speculation

SID = More M and Fewer X = (AD )

WES = Fewer M and More X = (AD )

LUKE, Use the FOREX

Changes (Δ) in AD• Δ Consumption (C)– C↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– C↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Gross Private Investment (IG)– IG↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– IG↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Government Spending (G) – G↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– G↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Net Exports (XN)– XN↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– XN↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

Increase in AD

C↑, IG↑, G↑ and/or XN↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑

GDPR

PL

AD

SRASLRAS

YF

P

Y

AD1

P1

Decrease in AD

C↓, IG↓, G↓ and/or XN↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

GDPR

PL

AD

SRAS

LRAS

YF

P

Y

AD1

P1

If the G has a balanced budget

• They are spending = to taxes collected• If they increase spending and don’t have a

balanced budget = borrowingIt will come from the loanable funds

market, therefore raising the r% by crowding us out.

If AD goes down

• Transfer payments will increase b/c the increase in u% will lead to more people applying for welfare and other benefits.

Extra determinates of AD

• ’▲ s consumer confidenceif we have optimism then AD>

• ’▲ s in wealth – assets value > then AD >• ’▲ s monetary policy – if the Fed > MS then AD>

AD Summary

• AD reflects an inv rel beetw PL and GDPR

• Δ in PL creates real-balance, i%, and foreign purchase effects that explain AD’s downward slope

• Δ in C, IG, G, XN cause Δ in GDPR bc they Δ AD.• Increase in AD = AD • Decrease in AD = AD

Full Employment• Full Employment equilibrium exists where AD

intersects SRAS & LRAS at the same point.

GDPR

PL

AD

SRASLRAS

YF

P

Recessionary Gap• A recessionary gap exists when equilibrium occurs

below full employment output.

GDPR

PL

AD

SRASLRAS

YF

P

Y

Inflationary Gap• An inflationary gap exists when equilibrium occurs

beyond full employment output.

GDPR

PL

AD

SRASLRAS

YF

P

Y

Increase in AD = Up/left movement along SRPC

C↑, IG↑, G↑ and/or XN↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑ .: up/left

along SRPC

GDPR

PL

AD

SRASLRAS

YF

P

Y

AD1

P1

SRPC

π

u

π%

u%un

π 1

. .. .

Decrease in AD = Down/right along SRPC

C↓, IG↓, G↓ and/or XN↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓ .: down/right

along SRPC

GDPR

PL

AD

SRAS

LRAS

YF

P

Y

AD1

P1

u%

π%

SRPC

un

π

u

π1

. .. .

Other Details:RATCHET EFFECT (or “sticky wages”)– Prices don’t always go down when AD shifts left due

to: wage contracts, worker morale, minimum wage laws, “menu costs” – costs to change prices up & down frequently & fear of “price wars” with competition.

SHORT RUN – period when wages & other costs are FIXED (suppliers need time to adjust to change in AD/AS)